http://scriabinop23.blogspot.com/2008/11/unsustainable-bubbles-deflation.html Two ideas with the theme of deflation considered. Here is why we can not afford a great depression, and the end game is ultimately inflation either way. <strong>1) Long treasury notes and bonds: 10-30 years</strong>. China is providing $586B in fiscal stimulus over the next two years. This equates to at least their current buying rate of treasuries. If oil prices stay this low, this is less money to come back to purchase our debt. Next, when TARP money stops coming to support the long end of the market, who else will buy? And finally, as our debt levels are unsustainable, a continued deflationary move will have a horribly negative effect on tax revenues when we are continuing to spend at furious rates. Today we can not <em>afford</em> a great depression, since we now have surpassing 70%+ debt to GDP, not to mention social security and medicare entitlements weighing us down. In 1929, debt to GDP was 16.3% (16.9B of debt against 103.6B GDP). Near the trough of the depression, debt ballooned to 27B against 66B of GDP, a debt to GDP ratio of 41%. Consider this: This was in a time without social security or medicare obligations. During the great depression, the GDP moving from 103.6B to 56.4B (falling 45%). Now, with over 10T of debt against 14.4T of GDP, we are at 70%. If we saw GDP fall 45% (to 8T) and merely maintained our debt level, new debt to GDP would be 125%. If we repeated a similar scale of debt increase (+70% from 10T), our new debts would would be at 17T against an 8T GDP with no meaningful personal savings backdrop. <em> <strong>At 5% interest (very optimistic), our debt service cost alone would be $850B/year!</strong></em> All against tax revenues at most around 1.5T (reflective of an 8T GDP). We spend that alone on Medicare and Social Security <em>right now</em>! Even as ideally helpful a lower trade deficit is for our currency, a new problem is introduced. Without money being exported in exchange for oil, there will be no buyers of this debt at such low yields. Which leads to... <strong>2) The US Dollar.</strong> With the velocity of money recently fallen precipitiously despite money supply up nearly 40% year over year, the strong dollar move is not sustainable against assets and any currencies not comparably boosting monetary supply. A strong dollar is consistent with a deflationary spiral, one we can not afford. With current deflationary trends in place, unless we bite the bullet and <em>almost entirely</em> cut social security, medicare, and defense spending (potentially destroying our military hegemony), we will not be able to avoid a spiraling out of control debt threatening to devalue our currency. I am not one to prognosticate so pessimistically that we will continue into a great depression, and rather assume the current (and future) money pump will eventually stimulate the economy into some sort of recovery. But we will be left with amplified debt obligations, increased money supply (which never has had deflationary impact historically), all while our GDP is reflective of a system with less leverage. That means muted earnings growth and a flat to mildly growing GDP at best. In layman's terms, that means this: do not expect our debt to GDP ratios falling anytime soon, <a href="http://www.engadget.com/2008/11/11/mini-nuclear-plant-is-safe-affordable-and-purifies-water-but-d/">barring an unexpected discovery (or policy move towards) of free energy</a>. Considering our newly gained financial memory putting us into a new era of regulation, it is fair to assume that upon monetary velocity recovering <em>this money supply will not be mopped up</em>. This injection of money into the system is meant to maintain GDP at current levels with a simultaneous downshift of leverage. As banks hand out the money after they eventually have successfully recapitalized, velocity will pick up and we will start to see inflation. But what about Japan? Don't they offer a guide to what happens when banks fail to write down assets, real estate bubbles collapse, and when deflation is unshakeable? To assume we will fall into Japan's past twenty year history of a depressed yield curve is dangerous, since they have savings to support it. There is real wealth and surplus that affords to keep their yields low. Low yields are the foundation of a strong currency, as investors are willing to let time pass without much return as perceived risk in holding the currency is minimal. Their amazingly high debt to GDP ratio is supported by gigantic personal savings (in deposits along with annual savings rates). Drawing conclusions from the data point of high debt to GDP ratios alone leads one in an erroneous direction, since it fails to consider the whole picture. Almost $6T US (550T yen) sit in personal savings in Japan, while government debt is at $7T. Japan has another $1T of reserves on top of this. This is no debtor's state, despite a 195% debt to GDP ratio. That is Japan's story, and allows for low yields. Our debt obligations are unlike Japan's in that we do not have the same cushion, and by function of the rule of large numbers. Who else is bigger to absorb our debt for which we do not have matching savings to offset (to keep yields low)? This all points to high yields and massive inflation. Silver, gold, and bond puts all sound good if your time horizon is longer than 2 weeks.